exchange rate regimes

for fixed rates

$AD$-$AS$ curve

• $AD$: $Y=Y(\frac{\bar{E}P}{P^{\ast }},G,T)$, with $(-,+,-)$
  • slopes down, higher $P$ causes higher $ϵ$, which means less demand for domestic goods → lower $Y$
• $AS$: $P=P^e(1+\mu )F(1-\frac{Y}{L},z)$
  • slopes up, higher $Y$, better employment workers etc.
    

$AS$ shifts towards $Y_n$, moving $P$ down

• however, can move $AD$ to the right using devaluation
  • i.e. $\Delta E<0$ for $\frac{EP}{P^{\ast }}$

flexible exchange rates dominate fixed exchange rates

• (fixed con) give up two macro instruments, interest rate and exchange rate
• (fixed con) anticipation of devaluing → investors ask for very high interest rates
• (flexible con) exchange rate likely fluctuates, can be difficult to control thru monetary policy

hard peg: replace domestic currency with foreign currency

• known as ‘dollarisation’ commonly for USD$